The FIRE movement is built around the 4% rule—the idea that you can safely withdraw 4% every year in retirement and not run out of money. It’s the mathematical formula upon which we’ve organized the past 10 years of our lives, and if math is our religion, the 4% rule is our scripture.
Even though the Trinity Study has been cited as the inspiration behind the 4% rule, the actual person who deduced this rule is Bill Bengen, a financial planner/MIT engineer. Back in 1994, he analysed every 30-year retirement period in modern U.S market history and discovered that 4% was the maximum safe withdrawal rate that withstood the worst recessions.
I was so busy parenting, I didn’t even realize he wrote an updated book called “A Richer Retirement” last year, so I was beyond excited when a friend told me about it and gave me a copy.
What shocked me the most about this book:
- How readable it is! Most finance books written by financial planner are dryer than week-old toast left out in the Sahara, but this book has so much useful and interesting data I couldn’t stop turning the pages. This guy is a bonified nerd and has thought about retirement from every possible angle.
- He says the 4% rule is no longer valid!
Here are my biggest take aways from this book and how it affects FIRE:
The 4% Rule Isn’t What Most People Think
When he derived the 4% rule, Bengen wasn’t thinking “How much should I withdraw in retirement.” He was thinking “What withdrawal rate would have survived the worst retirement sequence in modern history?”
And the SAFEMAX (maximum safe withdrawal rate) he came up with was 4.15% in 1994. It got rounded down to 4%.
In his new book, he has redone those calculations for the current environment and now SAFEMAX has been…raised to 4.7%!
So the 4% rule is now the 4.7% rule, and even then, most retirees can withdraw more than this. Bengen deduced this number from a hypothetical retiree from the year 1968—a particularly nasty combination of a bear market and high inflation.
The scenario:
- Roughly 60% stocks and 40% bonds
- Annual inflation adjustments using CPI
- A 30-year retirement
- Dying with zero dollars left
This was a worst-case scenario.
Using 4.7% withdrawal would be like building a house to withstand a Category 5 hurricane, when most likely you will never encounter that situation, just like most retirees will not hit this worst-case scenario.
But but but, you ask. What about inflation? Surely, 4.7% doesn’t take that into account?
Why Many Retirees End Up Dying Rich
One of the more surprising ideas in the book is that retirees often underspend. Most people think 4% doesn’t take inflation into account, but Bengen derived this number by increasing the withdrawal amount every year to the rate of inflation. He showed with many graphs (seriously, this guy loves graphs more than I love my husband) that you will have a significant amount left over if you just withdraw less than inflation each year.
In my experience, this is what happens for early retirees because it’s much easier to beat inflation if you no longer need to drive to work, eat out due to lack of time, or live in an expensive city for the jobs.
Also, this analysis ignores human behaviour. When markets fall, people naturally tighten their belts. When inflation is running rampant, early retirees get creative about what they eat, how they entertain themselves, etc.
So when you spend less than inflation, you end up with a substantial portfolio at the end of life.
Bengen argues contrary to popular belief, it’s more likely for retirees to end up dying with far more money than needed.
What Happens When You Double Retirement Length?
One of the biggest criticisms of the 4% rule is that it was originally designed around a 30-year retirement. Bengen mentions this as well. He conducted his research with regular retirees in mind, not the FIRE movement.
So, what happens when you double retirement length from 30 years to 60?
Intuitively, you’d expect the SAFEMAX to collapse.
Surprisingly, it doesn’t.
As it turns out, extending retirement from 30 years to 60 years lowers it from roughly 4.7% to 4.1%.
That’s encouraging news for anyone pursuing financial independence in their 30s or 40s, because the penalty for doubling the retirement time length is smaller than people assume.
What if the Shiller CAPE Ratio Is “Off the Charts”?
Bengen’s research uses the Shiller CAPE (Cyclically-Adjusted Price-to-Earnings) ratio—which compares stock prices to 10 years of inflation-adjusted earnings to gauge whether the market is currently expensive or cheap.
During the 30-year period in Bengen’s 1994 analysis, the Shiller CAPE ratio never exceeded 32.6.
But after his original publication, the Shiller CAPE jumped to 44.2 in 1999. Many critics of the 4% rule look at this and conclude that historical withdrawal rates no longer apply.
In this book, Bengen examined retirees who started retirement between 1997 and 2001, a period when Shiller CAPE ratios ranged from roughly 32 to 44. There were 17 retirement starting points in this sample—roughly one retiree every quarter over four years.
None produced a SAFEMAX lower than 5.4%.
Valuations do matter, but this suggest that very high valuations don’t automatically lead to dramatically lower SAFEMAX rates.
Bengen’s concludes that retirees facing elevated valuations may still reasonably use a SAFEMAX between 5.25% and 5.5%. There’s no need to default to the worst case 4.7% SAFEMAX, even with high valuations.
Inflation Is Scarier Than Recessions
One of Bengen’s most interesting observations is that inflation may be more dangerous than recessions.
Most retirees fear stock market crashes, when inflation is scarier.
He uses the analogy of a balloon with 2 holes. One hole is recessions. The other is inflation. Both are causing air to escape. Both hurt you because one crushes your overall net worth, and the other forces you to withdraw more than you planned.
When both happen at the same time—as they did in the 1970s—you have a real problem. And it’s why the infamous 1968 retiree became the worst case scenario with a 4.7% safe withdrawal rate.
Bengen thinks inflation is scarier because while recessions eventually recover, inflation sticks around.
However, because food and transportation are two big components of the CPI, these are 2 main areas that early retirees can optimize. Given that they no longer need to commute to work, don’t need to eat out as much as a convenience option, and have time to stack up deals and buy in bulk, these changes make a significant dent in the food and transportation categories, which collectively make up 31% of the CPI. Housing, at 44%. can also be optimized since retirees no longer need to live in big expensive cities for the jobs, so they can use location independence to their advantage, which wasn’t take into account in this research.
The Surprising Case for More Stocks
Another one of Bengen’s surprising conclusions is that retirees may benefit from increasing their stock allocation over time. This is the opposite to the conventional financial advisor advice of reducing stock exposure as you age in retirement.
This is because gradually increasing equities forces you to buy stocks after market declines through rebalancing. So, you’re systematically buying low. Bengen used a 60/40 allocation to derive the 4.15% rule, but advocates for moving to 73/26 (stocks/bonds) gradually in retirement, over time. This also approximately matches what we did over the past 10 years with our own investments.
There are many other useful insights in the book, including how often you should rebalance, the detailed math and graphs behind all the points above, leaving an inheritance for your kids vs. dying with 0, and many retiree case studies. I highly recommend reading this book. Not only does it assuage your early retirement fears, but he’s also very down-to-earth in admitting that this is a scientific analysis and not to be treated as a guarantee (since nothing in life is guaranteed).
Generally, the takeaway is this: 4% is not only safe, it takes into account inflation, works for long retirement periods of 60+years, high Shiller CAPE ratios, and is for the WORST case scenario. Also, he recommends managing your portfolio and not just setting it and forgetting it in retirement. When you’re working, you have more leeway to do that, since you’re in the accumulation phase. Draw down requires more attention, particularly in the beginning where it’s more susceptible to market downturns. As your portfolio grows over time, you don’t have to worry about it as much.
It also made me realize that we are way too pessimistic and drawing down too little. We are currently withdrawing $82,000 a year, which represents a withdrawal rate of just 2.6%. That’s too low.
Our withdrawal target really should be closer to 4%, knowing how incredibly conservative that is, which would currently be $127,000. This would represent a 50% increase in available spending, which is a pretty big change. And to be honest, I have no idea how else I can upgrade my life since we already moved to Vancouver and I feel like we’re living our best life.
I…guess I could buy a new car and…barely drive it since I hate driving. I don’t know, that doesn’t sound right. We will have to ponder this further and we’ll let you know what we decide. I still have zero interest in home ownership. Team Rent all the way!
What do you think? Have you read A Richer Retirement? What withdraw rate are you using? And what would you spend more on if your retirement budget got a 50% boost? Let’s hear it in the comments below!
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